If you have invested in several mutual fund schemes, then chances are that some of these funds have overlapping constituent stocks. Some overlapping stocks should ideally not concern investors, but when their valuation comprises a vast majority of your portfolio then it can set the alarm bells ringing.
Therefore, it is important to first identify to what extent these funds have overlapping actions, and then act on it, that is, sell one or more funds to ensure a healthy diversification of your portfolio.
And why not? After all, duplication in your portfolio can have a significant impact on your returns.
“It’s okay to have common stocks but when they constitute part of your portfolio, what happens is… when those stocks fall – your whole portfolio would fall. There are two scenarios that can arise in this. First, you wait and see if the overlap is small, and second is to sell some of your investments to reduce the overlap,” Vidya Bala, co-founder of Prime Investor, shared in a video on a video streaming platform.
He emphasizes that when they are focused too heavily, investors not only bear a great financial risk, but also lose out on other potential stocks that could be a great investment opportunity while the stocks in your portfolio have fallen.
How to identify
Identifying fund overlaps is quite simple using PrimeInvestor’s online tool. One can write the names of two mutual fund schemes and get the percentage overlap of the two fund schemes.
For example, HDFC Flexi Cap Fund and HDFC Top 100 Fund are shown to have 62 percent overlap. As a scroll down, one can also find these money allocations in common stocks which include Axis Bank, Airtel, BPCL and Cipla in this case.
One should see that 60 percent overlap is common in large cap or large oriented stocks. But anything over that is too much, like 70 percent. This means you don’t need to keep both currencies in the portfolio.
This is how the online overlap tool shows the common shares between two or more mutual fund schemes
Sometimes two funds under the same category by different AMCs carry a low overlap ratio. For example, Parag Parikh Flexi Cap and HDFC Flexi Cap have only 21.6 percent overlap.
How to correct
Once it has been established that two or more mutual funds have a significant proportion of common stock, one can decide which mutual funds to hold and which to sell. Although this seems like a difficult decision to make, but one can make a call based on the current valuation and other performance indicators such as sharpe ratio, standard deviation, performance on benchmarks, among other indicators.
It is also important to note that mutual fund houses tend to change their portfolios – so the overlap between different schemes is also subject to change.
So the next time you want to invest in a new mutual fund, try to remember the old adage: Don’t put all your eggs in one basket.
Here we share the advantages of portfolio diversification.
First Published: December 20, 2022, 02:45 PM IST
